Pound stuck near 4-month low as hard Brexiters emboldened in race to succeed May

By Sujata Rao

LONDON, May 28 (Reuters) - Sterling languished just off four-month lows on Tuesday, with the outcome of last week's European election seen possibly emboldening proponents of a no-deal Brexit as the battle to succeed Prime Minister Theresa May got underway.

With the Brexit Party handing the ruling Conservatives a drubbing in last week's European elections, many of the candidates vying for May's job are under pressure to deliver a more decisive break with the EU when Britain is scheduled to leave the bloc on Oct. 31.

May said last week she would step down on June 7.

While foreign minister Jeremy Hunt said no-deal Brexit would amount to "political suicide", other candidates, including front-runner Boris Johnson, have signalled they are prepared for that if Brussels does not reopen negotiations over May's unpopular withdrawal agreement.[nL8N23412L]

However, sterling's downside was limited by the fact that parties opposing Brexit also made sharp gains in the European vote.

"For the Brexit Party to get so many votes is a sign to politicians that people are not as afraid of the no-deal scenario as most members of parliament. So the no-deal risk has increased a bit," said Morten Lund, FX strategist at Nordea.

The British currency slipped 0.01% to $1.2678, having traded as low as $1.2605 last week GBP=D3. It was likewise flat versus the euro at 88.195 pence to stand just off four-month lows EURGBP=D3.

Lund said however no-deal Brexit probabilities remain around 15-20%, because lawmakers could call a no-confidence vote against any prime minister who chooses that route, potentially triggering snap elections.

"It's more or less priced in that Boris Johnson will become prime minister, so with the pricing now I don't see that much downside. I see sterling trading around these levels but with a downward bias," he said.

BREXIT COMPROMISE

The pound has fallen for three consecutive weeks versus the dollar and euro. It has lost 3% this month as May failed in her effort to find a Brexit compromise with the opposition Labour Party and then announced she was stepping down.

Many analysts noted, however, that the election had also rewarded the Liberal Democrat and Green parties, which have steadfastly opposed Brexit and want another referendum that could reverse the June 2016 vote to leave the EU.

The increased support for these groups as well as for the Brexit party -- opposite ends of the Brexit spectrum -- may imply a rising probability of a second referendum.

Esty Dwek, Chief Market Strategist at Dynamic Solutions, the research arm of Natixis Investment Managers, noted that while UK voting levels had been low, "remainers did better from voters who actually showed up. This might increase chances of a second referendum, but this isn't our base case scenario for now".

"Sterling hasn't benefited, given the uncertainty with Brexit remains centred around Mrs May’s successor," she added.

Options markets are indicating increasing jitters about the Oct. 31 deadline, with implied volatility contracts expiring after that date trading at a significant premium to those expiring earlier.

The premium for sterling puts -- the right to sell at a certain price -- has also risen compared to calls that confer the right to buy.

Options show jitters around Oct 31 Brexit datehttps://tmsnrt.rs/2Wa8Sc9

Sterling on roller-coaster since 2016https://tmsnrt.rs/2I1WykD

(Reporting by Tommy Wilkes and Sujata Rao Editing by Jason Neely, Ed Osmond and Frances Kerry)

((thomas.wilkes@thomsonreuters.com))

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